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Demonetisation update 14 – new insights

It is 25 days since the Indian PM’s announcement of demonetisation. It is becoming harder to find commentary that makes a original point on demonetisation of the government of India. But, I think I have found a few and I am sharing them here.

Prof. Indira Rajaraman’s piece makes the same point that other have made – about the logistics and one that others have not made – what she calls as ‘demonetisation without replacement’. She makes her points well and with some force of conviction.

She thinks that it is actually not allowed. RBI is required by law to redeem the currency notes. Only the RBI Central Board can cancel that and that too such cancellation is not done casually.

The statutory responsibility for upholding the guarantee underpinning paper currency is vested with RBI’s central board. That responsibility would have been fulfilled only if replacement currency was stocked and fully available at any of the several surrender nodes for demonetized currency in this vast country. An emergency meeting of the RBI central board is reported to have been held on the evening of 8 November. Even if the board was trying to be a team player by going along with what the government wanted to do, why would they recommend turning Rs500 and Rs1,000 notes into pumpkins at midnight, without checking if replacement currency was in stock?

It was the absence of preparation with replacement currency, well-stocked banks and functional ATMs that turned this into an unmitigated disaster, rather than the suddenness of the change.

Yes, of course, such an action will deaden the cash hoards of criminal and other elements. But it will also deaden the economy.

The flow of tax evasion, not the stocks accumulated from past tax evasion, is what matters. And GST is the most major assault we have attempted on that flow. [Link]

In short, she questions the underlying soundness of the cancellation without replacement. It might even be illegal, according to her. She questions the lack of preparation, she questions the need for the suddenness and she questions the assault on the stock of cash hoard while GST which was meant to curb the flow was already in motion and which required the co-operation of State governments ruled by other parties. Some (not all) of her questions are relevant, necessary and deserve responses.

Of course, as I had written enough times in recent weeks, the question of whether these costs were worth paying or not would have to wait for a year or two or more to be answered. Second, the question of addressing the stock vs. flow has been asked before and answered too. Both are important and they are not mutually exclusive.

As for surprise vs. preparation, to a degree, surprise was essential. But, what is the extent of dislocation that could have been and should have been avoided, even while conceding the need for a surprise? What are the lessons and take-aways for the State from this exercise, from what she calls an ‘unmitigated disaster’? Is the State taking away those lessons?

Someone kindly shared with me a research piece from the State Bank of India Economic Research team on how much of cash hoarding might or might not come back into the banking system:

Secondly, till date RBI has published twice the deposited/exchanged notes data with banks, with a gap of 9-days (i.e. 10-18 Nov and 10-27 Nov’16). If we closely look at the data, the daily working day average deposited/exchanged at banks has declined significantly from Rs 605 billion (10-18 Nov) to Rs 501 billion (19-27 Nov), i.e. a decline of 17%. In totality, between 10-27 Nov, Rs 8.44 lakh crores were deposited and
exchanged in the banks.

If we replicate these actual trends it means that around Rs 2. 5 lakh crores on a conservative basis will not be coming back into the system. Additionally, if a percentage of such unaccounted money is ultimately disclosed and taxed this will be beneficial to the Government as such taxes could be immediately factored in next year budget for welfare needs. [No link]

A friend had sent me an unsigned and un-linked article by email. I found the link, however. It makes a good case for a 200-Rupee note:

Industrial design has a mathematical concept called preferred numbers. Way back in 1870s, a French engineer Charles Renard proposed a system based on logarithmic scale to produce a limited number of sizes to cover a wide range. A variant of that internationally accepted system is the 1-2-5 series, which is widely used in minting coins and printing notes.

The 1, 2, 5, 10, 20, 50, 100, 200, 500, 1000… is that series. The beauty of the series is that any adjacent numbers differs by a product of 2 or 2.5. As a result, they are spaced close enough but cover a wide ground. How? Let us look at an Indian street vendor who still measures the fruit he sells on old-fashioned scales. If he has weights of 100gms, 200gms, 500gms and 1 kg, he can give you fruits in multiples of 100gms by using a maximum of three weights. E.g. 800 (500+200+100), 900 (500+200+200). In no case does the seller need to use four weights. If you must follow the decimal system, this is an extremely efficient system….

… The gap between Rs100 and Rs500 (1:5) has been too large. Over the last few years, it has produced inconvenience (certainly) and contributed to inflation (probably). It is well known that bigger values and larger gaps can increase prices. In January 2002, when most European currencies converted to Euro, prices rose on many goods as a result of rounding up. This rounding up phenomenon has made coins below one rupee disappear from India.

What India needs to do urgently is to introduce an Rs200 note. And if Rs1,000 is to be permanently abandoned, then to withdraw Rs2,000 as well. For efficient transactions, the ratio in the 1-2-5 series must never exceed 2.5. [Link]